dollarization vs. common latin american currency

The President of Brazil, Luiz Inacio Lula da Silva and his Argentine counterpart, Alberto Fernandezdefended this Monday the need to promote a common Latin American currency, which is planned to be called SOUTHto abandon the dependency of the dollar.

In the press conference that took place after the meeting between Da Silva and Fernández at the Casa Rosada, both leaders were asked about the future of the common currency.

The Argentine president, Alberto Fernández, pointed out the need to explore new forms of commercial and financial relations in the region given the failure that the dollarization of the economy has entailed.

One day before this bilateral meeting took place, both leaders had published a joint text on the website of the Argentine Presidencyin which, among other things, they defended their decision to “advance discussions on a common South American currency that can be used for both financial and trade flows, reducing operating costs and reducing external vulnerability.”

The Argentine Minister of Economy, Sergio Massawarned in the British newspaper Financial Times that this is a “first step on a long road” and noted that, although it is a bilateral initiative, other countries are expected to join.

Specifically, the president of Venezuela, Nicolas Maduroalready announced on Monday its support for the creation of a common currency for Latin America.

Despite this reluctance, the truth is that if a common currency were to be established for Latin America This would place the country at the forefront of the world economy, representing 5% of the world GDP. A value that would only be surpassed by another monetary block, the Euro, which currently reaches 14% of world GDP. Behind would be the CFA franca currency used in some African countries, and the East Caribbean Dollar.

One of the difficulties that Brazil and Argentina may face when adopting a common currency is the great difference between their respective economies. For a common currency to be effective, a prior confluence process must take place so that both countries have a similar economic structure and levels of development.

In the case of a common currency between Argentina and Brazil, Argentina would start from a disadvantaged position: without access to credit in international markets, with few foreign exchange reserves in the central bank and with soaring annual inflation that practically reaches 95%. Inflation could be the main stumbling block to achieve harmonization of both economies since the CPI in Brazil stands at over 5.9%, almost 90% below Argentina’s.

For its part, interest rates in Argentina are above 75%, while those in Brazil remain above 14%. This competitive disadvantage of Argentina is the reason why Alberto Fernandez is aware that the viability of the currency depends fundamentally on the political will of the Brazilian giant.

On the other hand, Brazil is its largest business partner, and only in 2022 bilateral trade between the two countries reached 26.4 billion dollars, which represents an increase of more than 20% compared to the previous year. Both countries are the engines of mercosurthe commercial block of the area, which also includes Uruguay and Paraguay.

The underlying debate between the dollarization of the Latin American economy and the creation of its own common currency is essentially political. The most paradigmatic case of dollarization of a Latin American economy is that of Ecuador, which adopted the US currency in the year 2000. Although it is true that, in the Ecuadorian case, the dollarization of the economy served to drastically lower inflation levels, which went from being above 90% to moderating to 10%, The truth is that there are also other Latin American countries that have managed to control inflation without having to renounce their monetary sovereignty. It is the case of Chile or Peru.

And in a dollarized economy, without the capacity for its own economic policy, periods of recession are paid for with pay cuts and with rising unemployment rates. Another disadvantage of dependence on a foreign currency is the destruction of the local industry. As a consequence, dollarized countries tend to become product-importing countries.

In the Argentine case, although there is no de facto dollarization of the economy, there is a informal dollarization. This means that the dollar is the currency used by citizens for all the important transactions of their daily lives, such as the purchase of homes, cars or trips.

In this context, there is a debate about the benefits/disadvantages of Argentina’s dependence on the US currency.

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